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If you have young children or
grandchildren, you may want to start
investing for them - and you should. As
you invest, however, you'll need to keep
a couple of key dates in mind - because
they can make a difference in your
family's tax situation and your control
of your child's or grandchild's assets.
One important date to
remember is the day your child or
grandchild turns 17 because that's the
last year he or she will be affected by
the "Kiddie Tax." The Kiddie Tax applies
to unearned income - typically from
investments held in the child's name -
above an annual threshold, which, in
2007, is $1,700. Of that $1,700, the
first $850 of earnings is tax free, but
the next $850 will be taxed at the
child's rate, which is typically 10
percent. Any income above that $1,700
will be taxed at the parents' rate,
which could be as high as 35 percent
However, while your child's
or grandchild's tax rate may be 10
percent, it doesn't necessarily mean
that every investment that generates
$850 in earnings will be taxed at that
same rate. For example, a child will
only have to pay a 5 percent tax rate on
income from most types of stock
dividends. (At least, that's the case
for now; Congress is considering
legislation that would subject the $850
- or whatever the future amount may be -
to the 10 percent rate, no matter what
the source of the income.)
On the other hand, if a
child invests in growth stocks - those
that generally don't pay dividends - he
or she won't generate significant
unearned income until after the shares
are sold. So, if you and your child or
grandchild follows a "buy and hold"
strategy with these stocks until the
child is at least 18, he or she would
only have to pay the capital gains tax,
which is currently just 5 percent for
people in the 10 percent tax bracket.
(This rate drops to 0 percent for the
years 2008 through 2010, but the
proposed legislative changes would deny
the 0 percent rate to children.)
Once your child or
grandchild turns 18, he or she will no
longer be affected by the Kiddie Tax.
The age of 18 is also important if
you've been investing for your children
or grandchildren through either the
Uniform Gift to Minors Act (UGMA) or the
Uniform Transfer to Minors Act (UTMA).
Essentially, UGMA/UTMA allows you to
fund an account for a child, but limit
the child's access to the account until
he or she reaches the age of majority -
either 18 or 21 in most states. The
child owns the account, but you are
named as custodian, and you control the
account until the child is no longer a
minor. At that point, the custodial
relationship ends and the child assumes
control over the account.
In other words, once the child is 18 (or
21), there's no guarantee that he or she
will use the money for college, as you
may have intended. So, if you really
want to put all your child's investment
money into a college fund, you might
want to consider a 529 College Savings
Plan, which gives you significant
control over the funds, along with tax
advantages. Contributions are
tax-deductible in certain states for
residents who participate in their own
state's plan. You should note that a 529
College Savings Plan could reduce a
beneficiary's ability to qualify for
financial aid.
In any case, if you've got investments
earmarked for your children or
grandchildren, be aware of the changes
that will occur once they turn 17 and
18. Those years can be challenging
enough without any financial
"surprises." |
